During the 1990s and early 2000s the tobacco industry became increasingly embroiled in litigationover the damages caused by cigarette smoking. Many states sued tobacco companies to recoverhealth care costs related to smoking. Several tobacco companies agreed to pay billions of dollars toMinnesota, Florida, Mississippi, Texas, New York, and other states. The tobacco companies thenfaced a difficult question. How would they pay for these legal settlements? Their response was toraise cigarette prices repeatedly.Why did cigarette producers believe that they could collect more revenues if they raised ciga-rette prices? And what information would they need to estimate the size of the increase in theirrevenues from an increase of, say, five cents per pack? As we saw in Chapter 2, firms can predict theeffects of a price increase if they know the shape of the market demand curve. An article in theThe Wall Street Journalsummarizes some of the extensive research on the market demand curvefor cigarettes. “The average price for a pack of cigarettes is about $2. Prices vary by state because oftaxes. Analysts say that for every 10 percent price increase, sales volumes drop between 3.5 percentand 4.5 percent. They say that small price increases generally don’t cause most consumers to try togive up smoking, but that they smoke fewer cigarettes each day.”1Based on this information, we would conclude that the price elasticity of demand for cigarettesis approximately −0.35 to −0.45. Thus the demand for cigarettes is relatively price inelastic. As welearned in Chapter 2, when demand is relatively inelastic, a small price increase will lead to anincrease in sales revenues. In the cigarette market, if price rises by 10 percent, sales volume will fallby about 4 percent. This means that with a 10 percent price increase, the revenues from cigarettesales would increase by about 6 percent. This explains why cigarette producers believed salesrevenues would rise if they increased cigarette prices.

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